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Capital Markets

Investors Will Continue Adding Shortening to Portfolios

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January 05, 2018

Members of NeuGroup’s TIMPG were shortening duration ahead of tax reform; this strategy will likely remain

Bond3“Shortening duration.” That’s one of the top answers given by many NeuGroup Treasury Investment Managers’ Peer Group (TIMPG) members when asked to explain current projects and priorities. This is a notable if perhaps unsurprising response to the external factors confronting cash investment managers in late 2017. These factors include the clear expectation that the Federal Reserve will respond to a healthy US economy with continued interest rate increases and the desire of members to avoid tying up cash in longer-dated instruments.

The other catalyst for shortening portfolio duration is the flexibility members seek with the coming reduction in the corporate income tax and likely repatriation of cash held overseas.

Multiple members from both NeuGroup TIMPG groups have been singing from the same hymnal when discussing plans to shorten duration in their cash portfolios. That’s because rising interest rates are the proverbial kryptonite of longer-term bond performance; no one wants to be locked in to a long bond whose value keeps erode as the Fed takes action. One member specifyied a duration of 5 to 6 months; another said he’s “keeping everything short,” adding that J.P. Morgan manages the firm’s 1-to-3-year duration portfolios while shorter duration instruments are managed in-house.

The key factor here of course is the Fed. Expectations of rising rates and the unwinding of the Fed’s balance sheet explains why some cash managers are shortening their duration and waiting to go farther out on the yield curve. One treasurer who wants to extend duration said he’s “hesitant to pull the trigger” because his fear of the of the 10-year Treasury popping up 100 basis points. He’s thus concluded that this “is not the time to buy 10-year bonds.” That followed a J.P. Morgan Asset Management strategist telling the group that, he “would not be surprised to see long-term rates go up 1 [percentage point].”

Another member, whose company had stopped buying 3- to 5-year Treasuries with cash held overseas, said he had done so in order to build liquidity in the portfolio ahead of tax reform and with the expectation his company would repatriate funds to the US. He said there’s no reason not to bring home cash the company holds overseas if it has to pay tax on that cash; and if the money is needed he doesn’t want to have to liquidate and risk taking a realized loss. He’s putting all the cash held overseas in money market funds.

In the final analysis, cash managers navigating uncharted territory of rising interest rates, the unwinding of the Fed’s balance sheet and the impact of recent tax reform, particularly the repatriation of cash held overseas. Most are moving ahead with plans to build flexibility to maneuver in this new environment by shortening duration and boosting liquidity. The challenge is that cash will provide negative real returns, making the case for investing in long-term assets with a 3-to-5-year duration. He sees opportunity in emerging market debt. Plenty to think about for cash investment managers adjusting to new fiscal and monetary realities.

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